Just tried this again, and it is still reproducible.
 
Did a fresh install of Ubuntu 10.04 LTS i386  in a VirtualBox VM.
Upon first boot, opened a terminal and typed sudo apt-get install p7zip
p7zip installed just fine.
Next I navigated to the "Examples" directory in my home folder, and chose the 
file
"Welcome_to_Ubuntu.odt" with a right click and then left clicked "Compress..." 
from the menu.
In the window that opened, I left the Filename entry as it was, and selected 
.7z as the file type.
I then clicked the the + sign by "Other Options"
I then entered in the box for "Password:" password
Then I  ticked the box for "Encrypt file list too"
Then I clicked on "Create" and recieved the error explained in my above post, 
and now shown in the attached screenshot.




** Attachment added: "Screenshot.png"
   http://launchpadlibrarian.net/47833406/Screenshot.png

-- 
.7z compression with encryption gives error
https://bugs.launchpad.net/bugs/557345
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